© 1998, jeffrey k. mackie-mason1 pricing and bundling electronic access to information jeffrey k....

© 1998, Jeffrey K. MacKie-Mason 1

Pricing and Bundling Electronic Access to Information

Jeffrey K. MacKie-MasonDept. of Economics and School of Information

University of Michigan

October 1998


Publishing

Reed Elsevier ($5.75 B)

Wolters-Kluwer ($2.75 B)

Motor vehicles andequipment

$85.1 B

Electronic and otherelectric equipment

$143.8 B

Printing and publishing $90.4 B

1996 US GDP

Gannett Co. ($1.3 B)

News Corp ($3.2 B)

1997 Sales


Selected Publishing M&A Activity

Harcourt General acquires Times Mirror’s Mosby Inc. ($415 MM) (9 Oct 98) Bertlesmann AG to buy 50% ($200 MM) in Barnes and Noble online (7 Oct

98) Penton Media to buy Mecklermedia ($200MM) (8 Oct 98) Wolters-Kluwer acquires Ovid Technologies (30 Sept 98) Microsoft in discussions with Reed Elsevier? (24 Sept 98, Assoc Press) Reed Elsevier acquires Matthew Bender and Shephard’s ($1.65 B) (27 Apr

98) Individual Inc. and Desktop Data and ADP/ISS (24 Feb 98) Washington Post and Newsbytes News Network (18 Dec 97) Reed Elsevier and Kluwer propose merger (13 Oct 97; abandoned) Reed Elsevier acquires Chilton Business Group ($447 MM) (23 June 97) Reed Elsevier acquires MDL Information Systems ($320 MM) (24 Mar 97) Reed Elsevier acquires Thomson legal titles (Feb 97)


Problems:– High first copy costs– Threat from “bypass publishing”– Incremental costs from new delivery media– Development risk for new value-added services

Opportunities with electronic pricing:– Revenue from new service provision– Extracting more value from heterogeneous users

Problems and Opportuntities


What is known about bundling?

v2

v1

Alice has strong taste for good 1, not much for good 2

Bob has middling taste for both

Bob

Alice


What is known?

v2

v1

p2

p1

Unbundled:Sell to those with few extreme values, not those with several low values

Alice buys good 1 (v1 > p1)

Bob buys nothing

Bob

Alice


What is known?

v2

v1

pB

pB

Alice

Bundle: Average across values.

Pick up the averages,

Lose the extremes

Bob


What is known?

v2

v1

pB

pB

AlicePure bundling

Bob buys bundle.

Alice does not.

Bob


What is known?

v2

v1

p2

p1

Bob

Alice

Mixed bundling

Both buy.

Offering choice of two price schemes rather than one increases sales

But not a general solution!

Buy #1

Buy #2Buy both


Early literature

Adams and Yellen (QJE 1976); McAfee, McMillan and Whinston (QJE 1989); Salinger (J Bus 1995)

Limited to 2 goods– drastically limits expression of customer heterogeneity and innovative

bundling

Didn’t examine behavior as marginal cost 0– defining feature of information goods


Recent efforts Chuang & Sirbu (1997), Bakos & Brynjolfsson (1997)

Explore N goods, but still very limited bundling possibilities– unbundled, fully bundled and self-selection between the two

– don’t consider partial bundles, or user-chooses bundles

Fully bundled tends to be profit maximizing when– consumers have similar “average intensity”

– economies of scale in distribution of info goods

– not always beneficial to readers

Outstanding issues: – heterogeneity

– dimensionality of product space

– publisher competition


Info goods are infinitely configurable

Word processing– Java component– “home” config– “pro” config– suite bundle

Stock data by the...– quote– day– exchange

With or without access to analyst reports, technical charts, &c.


Rebundling is opportunity and curse

Possibilities for 3 items: {A},{B},{C},{A,B},{A,C},{B,C},{A,B,C}

Complexity grows rapidly:

Items 3 5 20 NBundles 8 32 1,048,576 2̂ N

Need principled approach to exploring the design space


Our agenda

New mode of bundling for heterogeneity: generalized subscriptions (w/Riveros)

Competition when firms bundle (w/Fay)

Two-sided learning in differentiated product (bundle) space (w/Kephart et al.)– consumers learn about changing price/bundle offerings

– providers learn about consumer tastes and competitor strategies

Field research: PEAK


Simple bundling

If users have similar average values for info goods, offer large bundle:

“seller chooses”

If users have different average values, let them select individual components:

“buyer chooses”


What we know

Seller chooses:bundle

Buyer chooses:unbundle

Buyer chooses:unbundle

Seller chooses:bundle

Users similar Users different

Costslow

Costshigh


What we need

Real world(e.g., buyer chooses

w/sub-bundling)

Sellerchoose

Buyerchoose

Buyerchoose

Sellerchoose


Consumer preferences

How do consumers value articles from a collection?– For one consumer, each article can have different value

article n

w0

kN

Value of best article = w0

N articles; k is fraction user values > 0

w n wn

kN( ) FHG

IKJ0 1


Consumer heterogeneity

Let w0 and k vary across users– w0: most valued article

– k : fraction with value > 0

article n

w0

kN

Between two consumers, ranking and values can be different


Bundle options

Fully bundled: N=100 articles at pB

Unbundled: each article at pu

Generalized subscription (“user chooses sub-bundle”):NG=10 articles at pG


Bakos & Brynjolfsson B&B assume (main results):

– all individuals draw article values from same distribution as each other– all articles drawn from same distribution (LLN holds: sample average converges to

distribution mean)– so bundling is highly favored

Aggregate demand for bundle of size N:

p

articles sold

p

articles sold

N=1 article N=100 articles


Comparison to B&B

Profit bundled > GS > unbundled

Consumer’s surplus unbundled > GS > bundled

Quantity bundled > GS unbundled

Aggregate welfare bundled > GS unbundled

Homogeneous consumers

Two consumer types (different max value: wA, wB)– same orderings– but quantity drops from 48,400 to 24,300


More heterogeneity: Chuang & Sirbu Heterogeneity:

– different intensity: number of articles with value > 0 random:article values ~ U[0,1] for first ni ~ exp(13.9) articles

– heterogeneity not averaged out as N increases

Profit Unbundled > GS > bundled

Consumer’s surplus GS > bundled > unbundled

Total welfare GS > bundled unbundled

Profits increase by 10% when customers offered self-selection from menu of <GS, unbundled, bundled>


Next challenge: Competition

Prior lit has examined bundling by monopoly sellers; what happens with some competition?– Exceptions: Fishburn, Odlyzko, and Siders (Tech Rpt 1998); Matutes and

Regibeau (JIE 1992)

Some questions:– How much does competition reduce extraction of surplus?

– Can publishers in competition use bundling to recover fixed costs (is equilibrium sustainable)?

– What effect on incentives to create new content


Choice with competing bundles Assume articles randomly divided between two publishers

Consumers:– all articles are ex ante identical in value

– based on expectations, risk-neutral consumers decide among offerings: bundle, per item, or nothing -- want at most one of any article

– after purchase, values are revealed and consumers decide which items to read

Buyboth

BuyneitherBuy collection

1 only

Buy collection2 only

P2

P1VB-V2

VB-V1

V2

V1

Both firmsoffer bundlesonly:


Competing articles Suppose firms only offer to sell by the article

(One firm bundling, one offering articles lies in-between)

Buy some articles from both

Buyneither

Buy articles fromcollection 1 only

Buy articles fromcollection 2 only

P2

P1

w0

w0

Both firmsoffer articlesonly:


Results: Competition with homogeneous consumers

If both firms bundle:– efficient: all articles purchased (same as monopoly)

– competition leaves much more consumer’s surplus only 65% of monopoly profits even when competitor has only 20% share

– in a two-stage game with a fixed cost Fi to create Ni articles, incentives to invest efficiently are preserved in the duopoly

02

4

68

10

1214

161820

50-50 40-60 20-80

Monopoly profitDuopoly profit


Competition with homogeneous consumers (cont.)

If neither firm bundles:– Inefficient outcome: P > MC

– Lower: profits (13%) consumer’s surplus (9%) welfare (12%)

But if one bundles, one does not:– no pure strategy Bertrand (price competition) equilibrium


Heterogeneous customers: Monopoly

When customers were homogeneous (B&B), monopolist always prefers bundling

When heterogeneous (different values of k), offering self-selection mixture of bundles and articles dominates (divide and conquer)

Simple sub-bundling is inferior– since articles are substitutes, creating sub-bundles creates artificial

competition

– this ignores possibility of clustering by customer types to sort (different journals)


Heterogeneous customers: Competition

If both firms bundle: pure strategy Bertrand does not exist

If one or both sell unbundled, pure strategy equilibrium does exist (similar results with Stackelberg)– both have (much) higher social welfare than monopoly

But bundling is strategically advantageous: – firm that bundles earns more per item

– when both mix bundles and articles, nearly all revenue from the bundle

– larger firms can extract more surplus per item


Competition Extensions

Endogenize the bundling strategy– any outcome can result

– bundling is not dominant

– when mixtures are offered, most of the revenue comes from the bundle sales

Endogenize the collection size– monopoly bundling is inefficient, but captures more of the total surplus

– former effect dominates: the duopoly’s greater allocative efficiency makes duopoly investment incentives closer to efficient level than monopoly


PEAK Project Network access to 3.5 years of all 1100 Elsevier journals

Large scale field trial– 12 university, research lab and technical college libraries– over 100,000 authorized users – full text searching – high-resolution screen or print viewing

Over $325,000 in up-front payments

Experimental variation in choices available:– unbundled– bundled– user chooses sub-bundles


PEAK Bundles

Traditional subs: $6 / issue

Unbundled articles: $7

Buyer chooses “gen’l subs”: $548 / 100 articles


Clients subscribed to fraction of all print titles

But every authorized individual now has immediate desktop access to every page of every journal (at varying prices)

Client Code

Electronic Trad'l Subs

Gen'l Sub Articles

2 0 30003 16 18007 22 4809 844 6006 69 #N/A8 264 #N/A

10 205 #N/A4 #N/A 30005 #N/A 3360

11 #N/A 54001 #N/A #N/A


Articles Used by Institution

0

5000

10000

15000

20000

25000

30000

35000

Institution Code

Articles Used 47 1734 360 2125 3792 1 1364 101 32508 1 5254

1 2 3 4 5 6 7 8 9 10 11


Share of articles that were purchased

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Institution code

Unpurchased 26 899 268 1542 2219 1011 91 10340 1 3276

Purchased 21 835 92 583 1573 1 353 10 22168 1978

1 2 3 4 5 6 7 8 9 10 11


Articles used per trad'l sub

0.0 0.01.4 2.1

14.5

0.0

2.0

4.06.0

8.0

10.0

12.014.016.0

10 8 7 3 9

Institution code


Fraction of Gen'l Sub Tokens Used (annualized basis)

33% 33%

14%

59%

82% 75%

34%

0%

20%

40%

60%

80%

100%

2 3 4 5 7 9 11

Institution code


Summary

Low transactions costs enables plethora of disaggregated and reaggregated products

Workability needs more limited design space

We are extending the 2-extremes theory of bundling

We are studying competitive strategy when firms bundle

In PEAK we introduce user-chooses sub-bundles and test the ideas in the field

© 1998, jeffrey k. mackie-mason1 pricing and bundling electronic access to information jeffrey k....

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